The situation in Syria continues to deteriorate. The rebels, though divided, are acquiring heavy weapons (there have been reports they have some tanks), mostly by taking them from the regime. Apparently, the rebels are also attracting former soldiers who can operate such weapons. Still, there is nothing to suggest that either side is about to dominate the other and so the current civil conflict will likely continue.

The longer the conflict continues, the more outside powers will be tempted to intervene. In this report, we will discuss the issues with intervening in Syria, using Libya as a contrast. We will also examine the costs of not intervening and conclude with the impact on financial markets.

The Case Against Outside Intervention

There are a number of reasons why outside powers are reluctant to intervene directly into the Syrian situation. Here is a laundry list of issues:

The Syrian rebels are less unified compared to the Libyan rebels. The former is a wide array of ethnic, religious and tribal groups, many of which are not just different but opposed to each other. Various rebel leaders have tried to create umbrella groups to unify the various factions. However, thus far, divisions are wide and there have been some reports of rebel groups fighting each other. In Libya, the groups were united against Qaddafi and tended to act in concert. In fact, Qaddafi was so unpopular that he was eventually forced to import fighters from Chad and other areas for support.

In Libya, there was a natural division between eastern and western Libya. In fact, during the colonial period, Italy struggled to keep Libya together. Benghazi was the natural capital of eastern Libya while Tripoli was for the western portion. This natural division gave western nations a safe zone to defend and an area for Libyan rebels to congregate. In Syria, no such areas exist. There are regions dominated by a specific tribal, religious or ethnic group but there is no single area that can play this sanctuary role. Thus, for an intervening power, there is no physical place to establish a safe zone.

Geography favored air support in Libya, but not in Syria. In Libya, the area is mostly desert and flat. In Syria, there are several mountain ranges that reduce the effectiveness of air power, making a no-fly zone problematic.

Syria has a more formidable anti-aircraft defense system compared to Libya. The Assad regimes have been important recipients of Soviet and Russian air defense systems. Although Syria does not have state of the art systems (most of their weapons are from the Soviet era), the numbers of anti-aircraft weapons are large and would be difficult to suppress.

In Libya, Qaddafi’s air defenses were rudimentary and thus easier to overcome. If an outside power attempts to implement a no-fly zone, it will need to suppress Syria’s air defenses. It is reasonable to expect some aircraft and pilots would be lost and some collateral damage would occur because Syria has put much of its air defenses in populated areas.

Syria has weapons of mass destruction, whereas Libya did not. Libya was working on a nuclear weapon but voluntarily gave up that program after the U.S. ousted Saddam Hussein. When NATO began its bombing of Libya, Qaddafi did not have weapons that would threaten either Europe or surrounding nations. Syria has a large stockpile of chemical weapons that it could unleash on invaders or against neighboring countries in retribution for supporting Western military intervention. Thus, there is risk with moving against Assad because either Europe or an allied neighbor of Syria could become a target for an unconventional attack.

Syria’s geography and population centers make it difficult to establish safety zones and prevent a refugee problem. In Libya, the population centers were mostly around the northern coast along the Mediterranean Sea. Given their location they were easier to protect by air power. In addition, the population centers were relatively isolated from other cities in Egypt, Tunisia and Algeria, reducing the refugee risk. In fact, the biggest risk of refugees came from boats trying to get to Italy. In Syria, a refugee problem has already developed for Turkey and Jordan. In addition, the population is scattered and difficult to protect without ground forces.

Qaddafi was an international pariah, whereas Bashar Assad has strong allies. Qaddafi had the remarkable talent of alienating nearly every government in the world. The Arab states didn’t like him because he supported plans to assassinate leading political figures. He angered jihadists with his rather bizarre socialist teachings (he wrote a “little Green Book,” a similar missive to Mao’s “little Red Book”) that seemed to replace religion. He supported terrorist groups in other nations. His intelligence operatives arranged for the bombing of civilian aircraft. He had few friends in the region or the world. Syria, in contrast, is a key ally of Iran and represents a critical part of the Shiite Arc that runs from Iran through Lebanon. Russia is also an ally. Syria is its seventh largest customer for arms exports and Russia uses the port of Tarsus as a naval base; although small, it’s Russia’s only offshore base in the region. Russia and Iran will remain staunch allies to the Assads to the end. In addition, Syria is an ally to Lebanon (and dominates it) through its ties to Hezbollah, and is also aligned with the Iraqi government. The Assads could use either nation as a place to send military assets if a foreign power decided to invade or attack Syria.

Removing Qaddafi would not seriously threaten the region; the same cannot be said for removing Assad. Given Libya’s relative isolation, there was little risk that the problems in Libya would spill over into the rest of the region. Syria is a different situation. Already, Turkey and Jordan are suffering from a refugee issue and Western nations would likely use either nation as a base of operations. This decision would put either nation at risk if the West did not decisively overthrow the Assad regime and replace it with a friendly power. Given the persistent turmoil in Iraq, the inability to curtail the activities of the Taliban in Afghanistan or the lack of government in Libya, neither Turkey nor Jordan would likely believe any assurances given by the West.

Russia and China feel they were duped by the West into abstaining from UNSC 1970 (which authorized a no-fly zone over Libya) in the case of Russia, or voting for it in the case of China. Neither China nor Russia is comfortable with the notion that sovereign governments can be ousted over human rights violations if the U.N. agrees. The Russians point out that the U.S. hasn’t to date supported the Shiite uprising in Bahrain while wanting to use force to prevent a humanitarian crisis in Syria and Libya. The double standard suggests to Russia and China that the real motive of the U.S. and Europe was to remove Qaddafi from power, not prevent him from harming his citizens. Thus, neither government supports Western efforts to claim a U.N. mandate for force against the Assads. At the same time, Russia and China are uncomfortable with the notion that outside powers believe they have the right to intervene in a country over human rights abuses. They feel all nations have engaged in such abuses in their histories and for one country to attack another for this reason is simply hypocritical. In other words, these two members of the UNSC will reliably oppose military action for humanitarian reasons, worried that such rationale could be used against them as well. Thus, we doubt China and Russia would agree to a UNSC sponsored action.

The West may not really support ousting Assad on worries of creating another Islamist government in the midst of the Arab Spring. The Arab Spring continues to bring unrest throughout the region. Egypt now has a government dominated by the Muslim Brotherhood and Islamist political parties are becoming common in the region. Although many Western governments, including the U.S., officially support the drive for removing the authoritarian regimes in the region, there are concerns that these new governments may not be supportive of Western goals. In fact, they may oppose those goals. At a press conference earlier this year, President Obama was asked if Egypt was an ally of the U.S.—he responded that he wasn’t sure and would have to wait for the new government to clearly show if it wanted to be allied with the U.S. or not. Given that Egypt has received billions of U.S. dollars and President Mubarak was a stalwart for American interests, Obama’s statement came as a surprise. It does appear accurate, however. It isn’t clear if the new government is an American ally. Thus, it would be reasonable to believe that some Western governments may secretly hope that Assad survives, if for no other reason than to show that the Arab Spring undermining governments in the region isn’t inevitable. It is highly probable that Israel would prefer an Assad government to a radical Islamic regime.

The Costs of Non-Intervention

Although the costs of intervening in Syria are formidable, as we have detailed above, this does not mean that there are no costs avoided by non-intervention. The refugee situation is straining the resources of Turkey and Jordan. By some estimates, 40,000 Syrians have died in the unrest. If Assad falls without outside intervention, it may leave a serious power vacuum that may lead to borders changing and new states emerging.

Ramifications

It does not, at this juncture, appear that the costs of intervention exceed the costs of not intervening. Instead, there appears to be a “free-rider” problem, where no nation wants to bear the costs of intervening and allow the rest to enjoy the benefits. The U.S. has taken on this role in the past. At present, it does not appear that any other nation is willing to take on this mantle. This is a significant difference between Syria and Libya. In the latter, France and Britain faced a potential refugee problem without intervention. The U.S. was willing to support military operations and led the efforts initially but later turned the program over to the Europeans. So far, no other nations have been willing to accept the role of leadership.

The situation in Syria is yet another example of how the world changes without a global hegemon. The U.S. is becoming increasingly reluctant to play the role of the hegemon but hasn’t established regional powers to take its place. This, potentially, becomes a “G-0” world where power vacuums develop and regional wars become more common.

Such conditions tend to lead to secular bear markets in equities and support hard assets. We continue to tell investors to hold a lower risk profile in accounts and hold hard assets for protection against global geopolitical events.

Bill O’Grady

November 19, 2012

This report was prepared by Bill O’Grady of Confluence Investment Management LLC and reflects the current opinions of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.